We make thousands of decisions every day. Do I cross the road now, or wait for the oncoming truck to pass? Should I eat fries or a salad for lunch? How much should I tip the cab driver? We usually make these decisions with almost no thought, using what psychologists call “heuristics” – rules of thumb that enable us to navigate our lives. Without these mental shortcuts, we would be paralyzed by the multitude of daily choices. But in certain circumstances, these shortcuts lead to predictable errors – predictable, that is, if we know what to watch out for. Did you know, for example, that we are naturally biased towards selling investments that are doing well for us, but holding on to those that are doing poorly? Or that we often select sub-optimal insurance payment plans, and routinely purchase insurance that we don’t even need? And why do so many of us fail to enroll in our employer’s corporate retirement plans, even when the employer offers to match our contributions?
Behavioral finance is the study of these and dozens of other financial decision-making errors that can be avoided, if we are familiar with the biases that cause them. In this course, we examine these predictable errors, and discover where we are most susceptible to them. This course is intended to guide participants towards better financial choices. Learn how to improve your spending, saving, and investing decisions for the future.

MD

Insightfull short course on psychological background on investing. Recommend this course for any investment professional or amateur to learn about the most common pitfalls in investing

MS

Oct 21, 2018

Filled StarFilled StarFilled StarFilled StarFilled Star

Very informative . Learned a lot of concepts on behavioral finance and behavioral economics . I am sure they will go a long way in helping me in making better decisions !!

Из урока

Week 2

Welcome to the second week. In this session, we will discover how our minds are inclined to distort probabilities, and either underestimate or overestimate the likelihood of certain outcomes. We’ll also learn about “heuristic-driven bias”: the tendency to use rules of thumb that simplify the process of making decisions, but can also lead to predictable errors. These biases negatively affect our decision-making far more than we might expect; especially when the outcome of the decision has great significance for us.

Преподаватели

Emma Rasiel

Associate Chair and Professor

Текст видео

This is a fascinating area of behavioral finance, behavioral economics. The basic way to remember it is when you think about loss aversion and the endowment effect. The endowment effect is merely that when you own something or you've undertaken to own something, it becomes more valuable to you. And that sounds like a really, you say, of course, it does. It's more valuable, because I got it. But the truth is, it's very closely related to people's feelings about loss aversion. And so I'm going to try to put those together, give you some real life examples of how they fit together. And hopefully, you'll get an understanding of what we're talking about. The classic experiment for endowment theory is where you give a group of students and we do this in our classes. Half of them you give some mugs with their school on it. Nice and printed mugs, coffee mugs. And then the other half, you don't. And so everybody's required, the sellers and the buyers are required to write down the price that the buyers. How much they'd pay for the mug and how much would the sellers part with it. So, fascinating result. Well, here and it really is. The sellers are generally going to price the mug twice what the buyers are going to pay for it and that fits very closely with Professor Azeal's point earlier about loss aversion. Generally speaking, if you look at all the studies on loss aversion, there's a loss ratio. People are generally about 2.5 to 2 times more inclined to avoid losses than worry about whether or not they've got a game. And the endowment effect is very, very much related to that. When we own something, we assign a higher value to it. And what's also interesting is if you insert a third category into those buyers and sellers of those university coffee mugs in column choosers, what's really interesting is how closely they line up with the buyers? They don't own it. Therefore, they don't have any real bias and their price is pretty close to what the buyers are willing to bid for those mugs. So, that's a fascinating way of looking at or sort of looking at how we introduce the loss aversion along with the endowment effect. Now what's part of the endowment effect is also a heuristic, it's a bias of the status quo bias and where does that play into these things? Well, most likely, people, when they own something, they're willing to say there's a set of circumstances that has to be in place for them to part with it. The right price. The right time. There's a whole series of things in their lives that come into place when the decision to part with the good is. Now there's a long series of studies about whether or not, it matters what type of good it is. And in fact, you might surmise that the closer a good is to consumptive, i.e. Something like a bottle of wine or something like a coffee mug where we're going to use it that people apply more comfort in holding it or actually wanting more money for that since they are planning to use it for pleasure. In real life, that also extends to trading items too. Now we find this and we're going to talk in a few minutes about the stock market and why do people hold on to stocks far too long when in fact, they should have gotten rid of them before. It's a very similar principle and I think that we see it everyday in the financial markets. So just like the availability heuristic, the status quo bias, which of course is very much affected or very much part of the endowment affect has evolutionary roots. I talked earlier on the availability about how our ancestors way back when ate a kind of a berry. Maybe it was a red berry and they got bored with it. And so, they decided they wanted the blueberries. Were they, did our ancestors run out and immediately eat the blueberries? No. They had experimenters, either from their own clan or others to try them first and we're descended from folks who tried them second or third and they didn't die of poisoning. So, that's essentially where it all comes from. It is that mentality that we really do not want to take the loss or in that case, the big loss. It has a lot to do with why we hold on to things well past when, perhaps we should have gotten rid of them. So, let's talk a little bit about how the endowment effect plays in real life. So if losses loom larger than gains, then sellers typically will feel a greater loss than giving up their in the case of the coffee mugs. They'll feel a greater loss in giving up those mugs than the buyers would feel pleasure in getting them and that's the differential we're talking about. And again, it's 2, 2.5 times ratio. So, that's why sellers set a higher price. They're trying to offset since with their negative utility of having to give up that suddenly precious item, because they own it. And it's more, two times as much as the positive utility that would be experienced by buyers to acquire that mug and the price that the buyers put on it. And so it's a really important point, because what happens typically if you want to try to inoculate yourself against this endowment effect, which carries with it the status quo bias. You need to think more like traders think, good traders that is. Most traders think in terms of what are my options regardless of ownership? In other words, a good trader will think, what else could I do with my money right now than buy this mug? That's a rational way of fighting the endowment effect, both as a buyer and seller. So the seller should think, maybe 7 bucks or 6 bucks is too high for this. Maybe there's something else I could do with the money, even $3 since I just got this mug. That's another way of looking of how you fight it. Another, there's been some early interesting studies on this. The economist John List and this shows you, I think the fun part of behavior finance is that a lot of the studies that come in real life are they're fascinating. They look into fascinating arcania of society. Here's what he studied, the very imminent economist. He studied baseball card conventions, because he found some really interesting endowment effects in baseball card conventions. He found, for example, that folks who brought their cards for the first few times to these conventions had a really hard time selling. They couldn't part with that Babe Ruth 1935 card even though they're offered a very nice price for it. And what happened overtime, interestingly enough is unlike some of the biases that we have discussed and will discuss in this course. You can actually get better at trading by experiencing it. And so one of the things he discovered is the more conventions, an owner of card attended, the better they got finally at trading. They saw others doing it. They saw examples et cetera, et cetera. That's a really important part of message about business. Often, we learn our most valuable lessons from watching others who know what they're doing. I say that sometimes to students, they think, of course, but think about that. How many of us should seek role models and don't? Or we should ask for more advice, because we're afraid people would think we don't know what we're talking about, but that's in truly all wrapped up in the status quo endowment bias. We know we should do something else, but we're incapable of doing it, but we should ask for help and that's essentially the way to fight it.